What Really Matters When Transparency & Stability Matter in Markets

The high-frequency trading debate carries on, but are the right questions being asked? Scrutiny of incentives and defining 'fair' competition should merit more attention.

The recent publication of Michael Lewis’s new book re-ignited the debate on high-frequency trading (HFT) and its impact of the fairness and transparency in Financial Markets. The debate heated up even more as one of the sources in the story went public, trying to clarify his position that HFT does not lead to a rigged market.

The current discussion seems to imply that the markets need fixing and one of the first steps ought to be addressing the unfairness resulting from HFT. Somehow, the capacity and willingness of some traders to invest their capital in acquiring advanced technology and advanced analytics to compete is being presented as anti-competitive and inherently destabilizing. Would we have same the position if GM invests more than Ford in advanced robotics and contracts with specialized vendors for exclusive design of new manufacturing systems?

Historically, laws that address rules of competition and anti-trust issues have been formulated to define a minimum set of conditions rather than define limits on capabilities and constraints on business strategies. It has been left up to business to decide if they can effectively compete in a segment by scale, innovation or price advantages. The discussion of HFT comes uncomfortably close to suggesting that any practice that produces dissimilar outcomes for players are bound to be unfair and uncompetitive.

Do we believe that competition between participants is an effective way to create an efficient market and also serve investor interests? Do we believe competing includes discretion in directing capital investments for advantage including new technology and sophisticated analytics?

Since the Enron scandal and Sarbanes-Oxley, the preferred approach by regulators has been to increase monitoring of behavior and operations from trading desks to governance and reporting and to uses of technology. As this list keeps growing, we would be compelled to ask where the enforcement capacity and expertise will come from. It seems to be much more prudent to seek both stability and transparency and improve investor protection in structural reforms.

For instance, we might scrutinize securitization far more closely; especially where assets with valuations sensitive to household income growth and debt exposure are concerned, new standards and distribution criteria may be helpful. The manner in which ratings agencies work have hardly changed and there is certainly room for a new structure and supervision in that space. We have neglected to conclude the debate on whether we should continue to have insurance products (such as CDS) traded and regulated the same way as securities that are clearly investment products.

As exchanges abandoned mutual ownership and became publicly owned corporations, the incentive to leverage their own content is leading to offerings with different pricing schemes to those willing to pay for more timely and comprehensive content; it is in the nature of competitive markets that some will not afford to play the same game. Should we re-consider ownership structures for exchanges if we want access to information to be independent of ability to pay?

And finally, for investor interest, stability, and transparency, is there room to debate an updated version of the Glass-Steagall Act?

Before too much energy is consumed debating whether HFT is good or bad for the markets and investors, these questions and several others related to market structure merit attention.

Sinan Baskan is Vice President, Capital Markets for SAP. He is responsible for developing integrated solutions for Capital Markets and Business and Ecosystem Development. His team has developed and delivered solutions for e-Trading, Risk Analytics and Regulatory Reporting and ... View Full Bio

A very interesting article! I agree that HFT has become a focus for regulators but they are looking at the underlying issues, incentives, competition, transparency and stability as well.

Last's week hearing by Senate Permanent Subcomittee on Investigations (PSI), examined the incentives of payment for order flows from brokers and rebate pricing models from exchanges that are fueling internalization and HFT. So regulators are examining inducements beneath the market structure, such as PFOF which sends orders off exchange. During the hearing, Levin spoke of his concerns for investor confidence, transparency and stability. The same panel investigated the Flash Crash, so it seems that transparency and stability matter. But there is also a focus on restoring investor confidence, and that is underlying some of the regulatory initiatives.

Financial firms are continuing to innovate with the most advanced, fastest technology. This is the spirit of capitalism. But the proliferation of regulatory initiatives is shifting the technology investment to compliance and data warehouses.

Yes, and what an example it is! Because of the "lack" of transparency in dark pools, Barclays was able to market its dark pool to institutional investors as a safe haven from predators, when in reality it was full of HFT firms.

NY AG Schneiderman is pushing for more transparency into dark pools and this case is going to make or break his crusade.

It is going to be a question on how far Schneiderman pushes the case. A few people have commented that his case is pretty strong and the evidence against Barclays is substantial. Will Schneiderman push for the conviction, or will he let Barclays settle without admitting guilt? It will be interesting to watch.

Interesting article, Sinan. The idea that the problem is the technology is a bit simplistic, getting information quickly and using it wisely is the real gripe around HFT, but that innovation and investment doesn't seem like something to be regulated against. It's all very confusing for people following the debate, and it will be interesting to see where the discussion leads next.